May 12, 2013

The implosion of West Bengal’s Saradha Group –
real estate company, chit fund enterprise or a straightforward Ponzi operation,
Saradha defies definition – has led to the familiar blame game. Was it the
state government (the present or the previous one?) which turned a blind eye to
Saradha’s dizzying growth built on sand? Were the Reserve Bank of India and the
Securities and Exchange Board of India guilty of ignoring the flashing signals?
Are the regulations of the financial sector perennially behind market avarice?
Each time a highly “successful” finance company collapses, the questions posed
are the same. Only for the concerns to gradually subside before the next
collapse occurs. But the next time is never different.

The financialisation of household savings in
India can be traced back to the late 1970s with a shift in the policy
preference of the state. Indira Gandhi, in her address to the Federation of
Indian Chambers of Commerce and Industry on 25 April 1975 wondered “if
industrialists, even those who command the confidence of the investing public,
have done all that they can to tap private savings”. This call to tap private
savings of the investing public uncannily coincided with the rise of new
enterprises that then became the stuff of business lore in the 1980s. Many
business groups tapped into private household savings using money circulation
schemes and some of these went bust, the most infamous being Sanchayita
Investments in the early 1980s. The same period saw a proliferation of chit
fund schemes, many of which too collapsed. These became national issues leading
to the banning of money circulation schemes in 1978 and the promulgation of the
Chit Fund Act in 1982.

A market in primary equities was promoted in the
“zone of non-intervention” by the state along with deposit mobilisation. The
nationalisation of banks in 1969 set limits on the accumulating possibilities
for big players in finance. But with the dilution of equity by companies
covered by the then Foreign Exchange Regulations Act in the late 1970s, the
stock market came into its own followed by the first speculative boom of the
early 1980s. This collection of private savings was the basis of development of
private non-banking finance from the late 1970s.

It is a similar historical conjuncture of
proliferation of what today is called multi-level marketing (MLM) schemes that
saw the rise of new entrepreneurs many of whom collapsed in their Ponzi bids.
But some managed to successfully launder their way to build mammoth empires
spanning public deposit mobilisation, infrastructure and housing, media and
entertainment, aviation, consumer products, information technology, hospitals,
agro-business, mutual funds, housing finance, and hospitality. The accompanying
shift towards patron-client relationships between sections of aspiring capitalists
and ruling parties became a characteristic feature of Indian political economy
since the late 1970s.

So it is no surprise that this much-traversed
path would open up in West Bengal sooner or later as part of the rise of such
MLM schemes in eastern India spanning Bihar, Jharkhand, Odisha and West Bengal.
The spurt of robberies in Bihar in the early 2000s coincided with the collapse
of three of the largest Ponzi schemes in Bihar that had proliferated since the
1990s. Hence, Saradha and its partners in crime are part of a larger structural
phenomenon of finding an effective way to milch household savings.

Each story has its own particular “innovation”
(from Ponzi in 1920 to Madoff in 2008). In West Bengal, it was parivartanwhich
promised not only quick fixes to deep-rooted political problems, but also sold
the “get-rich-quick” neo-liberal dream in a state where unemployment was close
to 11%. This parivartan dream had powerful vendors criss-crossing glamour,
political control and lumpenised power, all of which were used to command an
organised patron-client structure between the film, media and political
glitterati aligned to the ruling party and economic scamsters and fraudsters.
This alliance appealed to the lower-middle class and working class base of political
parivartan by promising economic quick fixes. It is no coincidence that the
chief minister of West Bengal claimed that she had created two lakh jobs in her
first year of power. That number is close to the number of MLM agents who
signed up for Saradha and its competitors in crime. The same larger-than-life
leader who was going to “Save Bengal” as a political messiah was also going to
deliver freedom from the inter-generational mass economic hardships through
small investments in private enterprises like Saradha, which had on its
official payroll leading politicians of the ruling party and sponsorships
spanning media, real estate and exports, not to mention fraudulent
manufacturing enterprises. Reminiscent of Mackay: “Men…go mad in herds, while
they only recover their senses slowly, and one by one…”, the landscape had been
painted with the parivartan dream’s diffusion into the reality of fascism.

While the (occasional) irrationality of
financial markets is now widely accepted in perceptions of such scams, an
ahistorical analysis that focuses on the behaviour of small investors does not
permit any structural understanding. The laws against money laundering have
been in place since the late 1970s. But those are not preventive in nature.
Twenty years of deregulation of the financial sector in India has made these
laws toothless. On the one hand, it has paved the way for asset-stripping of
the state and financialisation of household assets and on the other, compounded
by the global crisis, it has slowed the growth of corporate savings and
investments. The regime of accumulation is thus geared towards contractor
capitalism’s Ponzi bids riding the crest of desperation of a protracted
agrarian crisis. Sudipta Sen and Saradha are not isolated instances but the systemic
surfacing of the poisonous potion that the crucible of fascist politics and
neo-liberal politics can possibly brew.

The Saradha group's collapse has
possibly bankrupted lakhs of small investors robbing them of their life
savings, and has rendered thousands of its agents jobless. The scam highlights
the failure of the government and its regulatory agencies to reign in the
mushrooming chit fund companies in West Bengal. It also brings under the
scanner the Trinamool Congress' proximity with the tainted group. In the wake
of the scandal, the article attempts to understand why the dubious Ponzi
schemes have thrived and flourished in state.

Subhanil Chowdhury
(subhanilc@gmail.com) teaches at the Institute of Development Studies, Kolkata

Sudipto Sen, the chairman of the Saradha
group of companies, was arrested in Kashmir on April 23, 2013, for allegedly
defrauding lakhs of depositors who had invested in various schemes floated by his
companies. After the Saradha group went bust, Mamta Banerjee, the chief
minister of West Bengal callously told the duped investors, “let go whatever
has gone”. However after two days, she announced a Rs 500 crore relief package
for the hapless investors. In light of the unfolding events, this article
attempts to analyse the political economy of the dubious shadow finance
organisations in West Bengal.

The Modus Operandi

Let us take a look at the modus operandi of
the Saradha Group of companies. The group collected money from the investors,
through agents, promising them either land or a flat, or an option for a refund
with a rate of return ranging between 12-24 per cent approximately, as per the
Securities Exchange Board of India (SEBI) notice.1 The agents in turn were
assured of a commission ranging from 15 to 20 per cent on the funds mobilised
by them, according to local media reports. In some schemes, the group promised
that on a deposit of Rs 1 lakh an investor will get Rs 10 lakhs after 14 years.
If the same amount of money was kept in a fixed deposit in a bank for the same
period, the amount accrued would be Rs 4 lakh. In other words, the rate of
return promised by the group was more than double of that promised by
commercial banks. According to some media estimates, the number of agents
employed by Saradha group may run into thousands or even in lakhs, while the
total amount of money mobilised by the group can run into thousands of crores.
The huge collection of money from the agents was deposited with the main
company which loated 160 companies (according to the letter submitted by
Sudipto Sen to the CBI), including a large number of newspapers in various
languages and TV channels in Bengali.

The entire money mobilisation exercise of the
group was, however, deeply problematic for a number of reasons. Firstly, in
none of the documents given to the Registrar of Companies did the group mention
anything about mobilising such huge amount of money from the public, and hence
kept itself out of the purview of either the Reserve bank of India (RBI) or
SEBI.2 The SEBI report also categorically mentions that the group never sought
any permission from it to run such a scheme. The promise of providing a plot of
land, or a flat after the maturity of the scheme was also a hoax. The SEBI
found that the land/flat allotted to the investors was not pre-determined, and
the investors had no control over the scheme, or the property. Moreover even
after repeated prodding by the SEBI, the group did not furnish the required information,
and tried to mislead it by providing voluminous data, which was basically
irrelevant. When at last they furnished the information, it was found that it
contained details of only 5 projects while the group stated to have acquired
land in 31 locations. The details of allocation, booking, cancellation etc,
were not provided, thereby prompting the SEBI to conclude that “it is highly
unlikely that the projects are actually in progress”.3 There are also reports
in the media that a motorcycle factory run by the group did not carry out any
manufacturing. The workers were told to act as if they were producing the bikes
when the group brought in investors to showcase the factory as an important
asset of the group.4 In short, the group’s functioning was blatantly illegal
and fraudulent.The working of the group in such blatant violation of all
regulations and laws shows a mammoth failure of the regulatory authority of the
government, both at the centre as well as the state level.

In April 2010, the Left Front government sent
a letter to the SEBI to investigate the group's activities. Prior to this, the
Left Front government had passed a bill first in 2003, and then in 2009, to
protect the interest of depositors and reign in such fraudulent companies. The
bill has sections under which the property of such companies could be
confiscated and auctioned to repay investors and charge them with criminal
culpability. But even after four years, the bill still awaits Presidential
assent. It can be argued that the Left Front government should have done more
in terms of devising some mechanism to either control the functioning of the
group, or at least alert the public. However, the matters came to a head under
the Trinamool Congress (TMC) government.

The Unholy Nexus: TMC and Saradha
Group

There are deep links between the Trinamool
Congress party and the Saradha group. The CEO of the group's media wing Mr.
Kunal Ghosh, and Mr. Srinjoy Bose, owner of the Pratidin newspaper, which has
extensive business deals with Saradha, are both TMC MPs. Newspapers such as
Pratidin, Sakalbela (owned by the Saradha group), etc, and TV channels such as
Channel 10 are practically mouthpieces of the TMC. The brazen manner in which
they support the chief minister Mamata Banerjee and the TMC makes a mockery of
journalism.

The TMC has been equally complicit in
patronising Saradha's media network. The TMC government had ordered all public
libraries to subscribe to newspapers owned by the Saradha group, including a
Bengali daily Kolom, which Mamta Bannerjee had inaugurated recently. Video
footage of her distributing ambulances, motorcycles and bicycles donated by the
Saradha Group in Jangalmahal in 2011, has also been circulating. It is also
reported that Sudipto Sen bought a painting of Banerjee for Rs 1.86 crore. The
TMC transport minister, Mr. Madan Mitra, was appointed the president of the
employees' union of the group, and at a programme organised by Saradha he
proclaimed that its owner Sudipto Sen was the pride of Bengal. Moreover till
April 15, the Chief minister feigned ignorance about Saradha being a chit fund
company. Infact in March 2013, Sachin Pilot the Union Minister of Company
Affairs placed in Loksabha, a list naming 73 companies from West Bengal who
were running Ponzi schemes. The list included the Saradha group. No action was
ever initiated by the TMC government against Saradha in the last two years.
Rather the growing proximity between the ruling party and the group only helped
in increasing the latter's credibility. After his arrest, the group's chairman
in a letter to the CBI claimed that TMC MPs like Kunal Ghosh and Srinjoy Bose
promised to protect him from the law if he acceded to their demands.

Reasons for Small Investors Flocking
to Saradha

As has been already noted, the Saradha group
promised a very high rate of return to the investors. It is true that the
investors did not know that the scheme was a big fraud. However, it was evident
that the abnormally high returns promised by the group was either not feasible,
or involved too much risk, which could lead to investors loosing all their
money. Currently, the rate of growth in India has slowed to 5.5 per cent, and
the rate of interest prevailing in the market is between 8 and 9 per cent. In
such a scenario to promise a rate of return above 20 per cent was blatantly
absurd. So why did the people give their hard earned money to such complete
fraudsters? There are number of reasons for this phenomenon.

Slide in small saving deposits- If we look at the
savings portfolio of the household sector in India, we find that between
2000-2005 the financial assets consisted of 12.8 per cent of GDP, while the
physical assets accounted for 12.9 per cent. However between 2005-2010, the
financial assets increased to 15.6 per cent of GDP, while physical assets
declined to 11.8 per cent. In other words there was a greater degree of
financialisation of savings in the second half of the last decade. If we
further analyse the financial savings data we find that bank deposits account
for the largest share-- increasing from 37.8 per cent in 2000-2005 to 51.6 per
cent in 2005-10. The share of life insurance fund and that of stocks and
debentures also witnessed a significant increase. However, there was a drastic
fall in the share of claims on government -- mainly the small savings schemes
-- which declined from 19.5 per cent in 2000-05 to 2.6 per cent in 2005-10.5
This drop in small savings holding is because of two reasons: (a) a decline in
the interest rates of the schemes on offer (b) the availability of other
financial instruments in the market made possible by economic liberalisation.

West Bengal has been particularly hit hard by
the fall in small savings deposits. The net collection from small savings was
Rs 6,238.93 crore in 2006-07. This increased to Rs 8,985 crore in
2009-10,marginally declined to Rs 8409 crore in 2010-11 and then and
subsequently declined to (-)987.22 crore in 2011-12.6 Therefore within two
years, approximately Rs 9,000 crore did not go to small savings schemes. The
question is where did this money go? This money, which was earlier mobilised by
the small savings scheme, must have been invested in financial instruments
which promised a higher rate of return than that provided by the small savings
schemes. Therefore, the shadow financial organisations like Saradha became an
obvious choice for the small investor.

Lowering of the rate of interest on
small savings -
The issue of lowering of the rate of interest on small savings is a direct
result of central government policies. With the opening up of the financial
sector and the concomitant liberalisation of financial institutions, the ruling
establishment has let markets determine financial investments. As a result,
various committees of the central government which looked into the issue of
small savings suggested that the interest rate should be market-determined, or
it should be aligned with the interest rate obtainable on government securities
of the same maturity. With lower rates of interest on small savings, and lower
financial inclusion, fraudulent companies like Saradha group become the obvious
choice of the people to deposit their savings.

Low Financial Inclusion -The state of West
Bengal has one of the lowest ranks in financial inclusion in the country, as
stated in a working paper published by the RBI.7 Excluding Kolkata, all other
districts of West Bengal have very low financial inclusion. The Index of Financial
Inclusion (IFI) constructed by this RBI paper has a maximum value of 1. Most of
the districts in the state have a value of IFI less than 0.1, with some like
South 24 Parganas having a value of 0.01.8Given such abysmally low levels of
financial inclusion, most of the people in the state are outside the net of
organised financial institutions. Therefore, the people park their savings in
shadow finance institutions like the Saradha who promise a rate of return much
higher than that offered by the commercial banks.

Several reasons can be cited for this low
rate of financial inclusion in West Bengal. The RBI Working Paper, mentioned
above, states that the main reason why the people do not keep their money in
banks is that their income level is not sufficient to open and operate bank
accounts. There is a lack of awareness about banking facilities and the
benefits that banks offer. Since most of the people do not have a collateral
against which they can take loans, they borrow from the rural money lenders and
carry on their banking transactions in the informal sector. While all these
factors are important in understanding why financial inclusion has lagged
behind in West Bengal, the change in banking policies with the introduction of
liberalisation should not be underestimated. With the advent of economic
reforms in the early nineties, there has been a decline in the bank offices
opened in the rural areas (from 35,360 in 1993 to 31,667 in 2009), while the
number of offices in the urban areas have increased significantly. Moreover,
there is a huge concentration of both credit and deposit in the urban and
metropolitan areas, which account for 77 per cent of the deposits and 80.4 per
cent of the total credit provided by the scheduled commercial banks in 2009.9 With
the banking sector's focus on earning more profits, the social aspects of
banking has been adversely affected. The norms of opening branches in the rural
sector and providing banking services to the poor have not been adhered to by
the private banks. The public sector banks have to compete with the private
banks and are reluctant to open more branches in the rural areas, or areas
where financial inclusion is low. The net result has been that in a state like
West Bengal, which is a predominantly agricultural state, majority of the
people living in rural areas have not been included in the organised financial
sector.

Lured by Saradha

However, two sets of questions can be raised
at this point. (a) Any financial venture has to be based upon the trust factor.
Why did the people even believe what the Saradha group promised? (b) Why did
thousands of people enroll as agents of this kind of a dubious group? I have
tried to answer these questions.

a) Information asymmetry - With respect to the
issue of trust, the first point that needs to be made is that there was an
acute information asymmetry between the Saradha group and its customers. The
Saradha group chairman was fully aware that he was running a fraud company, and
that his promise of a higher rate of return was false. But the customers had
faith in that promise and believed that they will reap high dividends.

In any financial transaction such information
asymmetry can be present. This is normally dealt with by a regulatory mechanism
as it exists in case of Banks and other financial companies. The regulator
along with the government’s statutory authority maintains faith in the working
of financial instruments. But in case of Saradha, no such mechanism in terms of
a regulatory framework existed. What existed was the active patronage of the
company by the TMC.

The information asymmetry got exacerbated
because of the group's connection with the political party. Primarily, money
was invested in Saradha by the people on the belief that both the TMC and the
state government were behind the company. There were also some media reports
that the Saradha group chairman had asked its agents to actively campaign for
the TMC in the 2011 assembly elections. In other words, the trust was earned by
Saradha because of the patronage provided by the TMC. People put their bet on
Saradha looking at TMC as the guarantor. This kind of political underwriting of
a dubious financial organisation by the ruling party is unique in the history
of West Bengal. However at the same time it must be highlighted that the people
did not use their judgment to invest prudently. Though most people were misled
by Saradha and its association with the TMC, given their weak educational and
class background, it cannot be denied that they got lured by high profits
offered by the Ponzi schemes.

b) Seeking employment with Saradha - The employment
situation in the state is under severe stress with a huge informalisation of
the labour force. While it is true that this informalisation is an all-India
phenomenon, the proportion of informal workers is higher in West Bengal than in
rest of the country. In India around 75 per cent of the rural workers and 69
per cent of the urban workers worked in informal sector, while for West Bengal
the numbers were 86 per cent and 71 per cent respectively. 10 The manufacturing
as well as the agricultural sector in the state has also witnessed a slowdown,
particularly in the last two years of the TMC rule. The share of manufacturing
in GSDP in West Bengal has has been steadily declining. Therefore, with a fall
in the share of manufacturing, income of the informal workers was adversely
affected. Moreover even after the implementation of NREGA, there has been only
a minimal increase in real wages of unskilled workers in rural areas as compared
to the rest of the country.11 The huge informalised workforce, in search of a
better livelihood, was lured by companies like Saradha with the promise of a
huge commission. In the meantime, the central government also cut the
commission of the agents of LIC and other small savings instruments. These
agents therefore decided to seek employment with Saradha and other similar
companies.

There was yet another reason why people
gravitated towards Saradha. The growth in West Bengal has been mainly led by the
services sector, and more specifically the real estate and construction sector.
These are two sectors whose share in GSDP has increased significantly in the
recent period. Therefore, the common perception of the people was that this is
a booming sector, and hence nobody will suffer a loss if money was invested
here. Since Saradha’s main investments were supposedly in real estate, this
attracted both agents as well as investors to the company.

Not Borrowing from Banks

Another important aspect of these shadow
finance institutions has to be highlighted. Saradha and other companies of the
same ilk raised money from customers at a higher rate compared to what the
banks would have charged them if they had borrowed from them. The
credit-deposit ratio in West Bengal fell from 64.8 per cent in March 2010, to
62.9 per cent in March 2012. These figures indicate that the credit market in
West Bengal was definitely not supply constrained. Therefore if somebody wanted
to start a business, s/he could easily borrow from banks at a reasonable
interest rate. Given this situation why were companies like Saradha collecting
money from public with a commitment to pay a higher rate of return, than borrow
from banks? Firstly, if these companies had borrowed from the banks then they
would have had to observe certain norms of financial prudence. These norms
ensured that excessive risk was not taken by the borrowers, and that in case of
default the money could be rescued by auctioning the collateral. The basic
motive of companies like Saradha was to either dupe people, or speculate in
excessively risky assets. This could not have been done by borrowing money from
the commercial banks. Therefore, they took the route of borrowing money from
the public, bypassing all rules and regulations. They were unconcerned with the
fact that the inevitable bursting of the bubble would lead to a loss of
livelihoods and lives.

Need for a Regulatory Framework

The only way to deal with such problem is to
organise a clamp down on such companies, and at the same time ensure financial
inclusion of the people. What is clear from the Saradha case is that there has
been a breakdown of the regulatory framework. This has been facilitated by an
absence of suitable laws at the state level, and a lack of vigilance on the
part of both the government as well as regulators like the SEBI. What is
required, therefore, is to have a sound regulatory framework to deal with
companies like Saradha. The experience of Tripura can be of help here. The
state had formulated an act protecting the interests of depositors in 2000, and
then amended it in 2011. As a result of this act, the menace of such companies
has been greatly reduced in Tripura.12 At the same time a central law must also
be passed to deal with such fraudulent financial enterprises.

However on an immediate basis, the people who
have lost their money should be protected. The setting up of a Rs 500 crore
relief fund by the chief minister for the affected investors is fraught with
many bureaucratic hurdles. Without a proper regulatory framework in place, this
kind of announcement might embolden other such companies to become even more
reckless knowing well that the government will refund the defrauded investors.
Therefore instead of announcing token relief for the people, which in any case
is too little and too late, the government should concentrate upon bringing to
book all those who are involved with this scam irrespective of their political
colour. They should confiscate and auction the property of Saradha to pay back
the investors in the least possible time, and develop a proper regulatory
framework to deal with all such companies. Unless these measures are taken,
tragedies like the busting of Saradha will recur in West Bengal.

References:

1. The Stock Exchange Board of India (SEBI)
in its notice dated April 23, 2013 (No. WTM/RKA/ERO-CIS/19/2013) has given some
details regarding the schemes floated by the group.

2. Chit Wriggles past Watchdogs, The
Telegraph, 20 April, 2013.

3. All details from the SEBI notice dated
April 23, 2013.

4. Bengali daily ‘Ei Samay’, 24 April.

5. All data quoted from Report of the
Sub-Group on Household Sector Saving during the Twelfth Five-Year Plan (2012-13
to 2016-17) Planning Commission.

6. Statistical Appendix, Economic Review,
2012-13, Government of West Bengal.

7. Financial Inclusion in India: A case-study
of West Bengal, Sadhan Kumar Chattopadhyay, RBI Working Paper Series, August
2011.

8. Financial Inclusion in India: A case-study
of West Bengal, Sadhan Kumar Chattopadhyay, RBI Working Paper Series, August
2011.